The markets have been a roller coaster lately. Should I have a different investment strategy during more volatile periods?
Stocks have been experiencing a great deal of volatility lately. The CBOE Volatility Index has seen multiple days with extremely sharp moves, the most since 2014. Higher volatility reflects greater price swings in both positive and negative directions and is a general measure of risk and uncertainty about the future direction of the markets.
As investors, it is important not to overreact to outside noise and stray from your investment strategy in the face of volatile markets. Acting based on emotion and fear can cause you to make mistakes that can negatively impact your long-term investment performance. During periods of higher volatility, consider some of the following tips:
Fight the impulse to sell your holdings if the markets are dropping. Selling after drops can make temporary losses permanent and difficult to recover from. Sticking to your investment strategy, while difficult emotionally, may be healthier for your portfolio. It is important to continue monitoring your investments, but remember the long-term reasons the investment is in your portfolio. What role is it playing? If it is still a good fit, holding the investment may be the better long-term strategy.
Remember that you are investing for the long term. Markets have always fluctuated up and down, and during your lifetime you’re likely to experience several significant declines. Timing when the market has hit a bottom is nearly impossible. Investors should ignore the noise and stay disciplined to the investment strategy they designed. The strategy was created specifically to avoid falling into these pitfalls.
Review your risk tolerance. Risk you took on years ago may no longer make sense given your current circumstances and life stage. If you are less open to risk, consider adjusting your target asset allocation.
Make sure your portfolio is well diversified. Volatile markets can expose improperly diversified portfolios. Review your portfolio and target asset allocation and make sure your investments are well diversified across a range of asset classes.
Rebalance your portfolio. Market volatility can skew your allocation from its original target. Certain assets will be more affected by market swings and will move outside their target allocations. Rebalance your portfolio by selling positions that have become overweight in relation to the rest of your portfolio, and move the proceeds to positions that have become underweight.
Consider defensive measures for your portfolio. If you must trade during volatile markets, there are defensive steps you can take to protect your positions. Stop orders and stop-limit orders can help shield unrealized gains or limit potential losses on an existing position. In addition, defensive assets, such as cash and cash equivalents and Treasury securities and other U.S. government bonds, can help stabilize a portfolio when stocks are slipping.
Following these tips will help you stay disciplined in your investment strategy and avoid making emotional mistakes.
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